STRENGTHS

WEAKNESSES

Significant political tensions between different ethnic and religious minorities and the Shiite majority in power.

Risk of a split from autonomous Kurdistan, an important contributor to the oil sector.

Cost of reconstruction following the armed conflict weighing on government finances.

Low weight of the private non-hydrocarbon sector in GDP.

Risk assessment

The Iraqi economy is facing a double shock

Iraqi growth will remain limited by the ongoing war conducted against Islamic State as well as by the fall in the oil price since June 2014. It should nevertheless post a slight rebound in 2016 after the increase of oil production. Given that 87% of the oil production is concentrated in the Basra southern fields spared by the clashes, oil production has not been very affected by the conflict. The increase in the number of oil qualities that are allowed to export has led to an increase in production of heavier sour crude oil in the southern fields. Moreover, the agreement between Iraqi Kurdistan and the Bagdad central government signed in December 2014 paved the way for an upswing in exports from the northern regions. Total Iraqi production increased from 2.5 million bbl./day in 2014 to 3.1 million bbl./day in September 2015 and it is expected to reach 3.3 million bbl./day in 2016.

The stalemate in the war against Islamic States which controls one-third of the territory should continue to destroy a significant part of economic base, while the other part is paralysed by the proximity of the conflict. Iraq has faced a serious humanitarian crisis since 2014 as more than 10% of the population has been displaced, as the country still receiving refugees from Syria. The IMF estimates that 10 million Iraqis, i.e. more than one-third de the population, may need humanitarian assistance. This number could increase in 2016 given the time it will take to rebuild basic infrastructure.

The contraction in budget receipts is likely to sharply limit the government’s contribution to the economy as a significant part of the budget remains allocated to the war effort. The almost non-existent private sector will continue to suffer from a decline in household and investor confidence. Consumption is also likely to slow down after the wage freeze for civil servants, which account for 50% of the working population. The reconstruction efforts in the territories recovered from Daesh could generate a slight recovery in activity in the affected areas, even though this recovery could be limited by the corruption problems and by the scale of the delays in the timetable for implementation. Inflation should remain muted in the Iraqi areas but be higher in the areas occupied by Daesh.

Slight reduction in the huge twin deficits

As more than 80% of the budget receipts stem from oil, the low hydrocarbon prices are detrimental for public finances. The Iraqi state has lost 40% of its budget receipts since the fall in the oil price in 2014 while it faces an increase in its military spending. The budget crisis has been all the more serious as despite certain measures aiming to reduce spending in 2015; the fiscal deficit has exceeded 20% of GDP. The fiscal deficit will probably shrink somewhat in 2016 because of the increase in oil production and the entry into force of new taxes. Civil servant pay is likely to suffer the consequences of the budget cuts. The wage freeze in 2015 could give rise to a fall in civil servant wages in 2016. The government should be able to borrow domestically in order to cover its substantial fiscal deficits, which will lead to a pronounced increase in the public debt. Given the regional instability, any prospect for borrowing in international financial markets is bleak. The Iraqi government can nevertheless count on support from international institutions, especially as regards humanitarian aid. The IMF is expected to grant aid in the form of emergency financing (RFI, Rapid Financing Instrument). The World Bank will contribute to a reconstruction fund aimed at the liberated areas for an amount of USD 350 million. Lastly, Kuwait and the United Nations will reportedly donate respectively USD 300 and 500 million in aid to refugees.

The current account, which has been negative since 2014, recorded a substantial deficit in 2015 as a result of the contraction in oil revenues. The increase in oil production in 2016 should, however, enable a slight decline in this deficit.

An entrenched war in a situation of increasing tensions between communities

While the international coalition is bombarding Islamic State’s positions, the army and the Shiite militias are gradually regaining lost ground in the areas occupied by the Islamic organisation. But the border between liberated and occupied areas changes continuously and the Iraqi army still faces defeats on the battlefield. The intensification of the strikes in Syria by the coalition France and Russia have joined could mark a turning point in the outcome of the conflict by weakening the organisation of Islamic State within its fall back areas. The war against Daesh will have an impact on Iraq’s political future. The community tensions between Sunnites and Shiites, which created the foundation for Islamic State after the anti-Sunnite purges, particularly in the army and the administration orchestrated by the previous prime minister Nouri al-Maliki, have not disappeared. The acts of violence perpetrated by the Shiite militias against the Sunnite tribes in the areas taken back from Islamic State may increase the risk of split and uprising. The central government under the leadership of Haider al-Abadi, shaken by corruption scandals, is increasingly being criticised by the Shiite parties linked to the militias and his leeway is decreasing.